Merill Lynch’s ghost rides on old herd-instinct in visions of gloom
• BofA Securities report shows fund managers expect a record steepness in the yield curve
None of the firms that made Wall Street the centre of world finance had the prestige of the House of Morgan.
JP Morgan (it was a person before it was a bank) at one point acted as the lender of last resort to the US federal government and many countries abroad. The US government, which considered Morgan too powerful, split it into JP Morgan, the retail bank, and Morgan Stanley, the investment bank.
In the 20th century the German Jewish-dominated Goldman Sachs achieved top tier status with creativity, which made up for what it lacked, relative to Morgan, in muscle. By contrast Merrill Lynch, dominated by Irish-Americans, was superb at sales. It became the most successful of the wirehouses, with a network of brokers selling shares to doctors and dentists in towns such as Peoria, Illinois.
In effect, they played the role of today’s financial adviser, though perhaps closer in spirit to those agents from Old Mutual and Sanlam specialising in investment.
Merrill Lynch had one of the most successful US advertising campaigns under the “Thundering Herd” theme and many will still recognise the Merrill Lynch bull. Of course, many investors believe that acting like the herd is the exact opposite of good investing. Merrill Lynch’s more intellectual competitors tended to mock its policy of giving the same message through its agents around the US.
Merrill Lynch did not have plans to move into SA, but did so by default. To gain more traction in the City of London it bought the midsized stockbroker Smith New Court. It was a good cultural fit, the biggest bone of contention being the Merrill team’s preference for Irish whiskey and the Smith team’s preference for Scotch. Smith New Court owned equity in Davis (later Smith) Borkum Hare, and its chairperson, the flamboyant super salesman Max Borkum, had no difficulty fitting into the Merrill Lynch culture either.
Unfortunately, charisma was not enough to save Merrill Lynch during the global financial crisis. It is now buried in the bland banking conglomerate Bank of America (BofA) headquartered in Charlotte, which is regularly voted the dullest big city in the US. The only sign left of Merrill Lynch these days is the “ml” that is part of staff e-mail addresses.
But the old Merrill Lynch research goes on. We just have to get used to referring to it as BofA Securities. Its fund manager surveys have often proved to be contra-indicators. They assume that the wisdom of the herd will be right, but often it is not. And there is a mismatch between the questions, which are confined to a 12-month horizon, and the good fund manager’s of three to five years.
But the overall pessimism in its May report looks justified. Things could be even worse. The herd expects a 28% fall in the JSE all share index from its peak, and some fund managers expect it to fall to 37,000 (down from the current 52,000). A net 50 managers in SA see more buys than selling opportunities, and 57% believe the equity market is undervalued. In the past, when readings have been close to this level, equities had an average 14% recovery over the next 12 months.
Managers are expecting a record steepness in the yield curve, with the average forecast for the repo rate in 12 months of 4.4% and a 9.7% yield for the 10year bond. Most investors are overweight cash but are planning to deploy this into equities when they hit target prices, and then bonds once there is some clarity there.
There is an interesting mix of sectors favoured by fund managers. Banks are facing a traumatic year, but this is more than reflected in the share prices. Even if they have to hold their next dividends, Absa and Nedbank are cheap as they have never traded at a 14%-16% dividend yield. Their bad debts will increase, and their overheads will increase because of the coronavirus. But one thing is for sure, the government cannot afford to let them fail.
Tobacco, which means British American Tobacco (BAT), is another favourite as it is unlikely that it will be forced to suspend its dividend at its UK home base and it remains a large cash generator. SA is a valued market for BAT, but it barely notices the loss of revenue from SA in the lockdown in its overall mix. Smoking is probably increasing in its other markets.
Platinum is also favoured, partly because fund managers take comfort holding last year’s winners. Right now many would argue gold looks more attractive on a 12-month view.
The least favourite are real estate and chemicals. Real estate is suffering from virus-specific issues as tenants cannot pay rent, but after Covid-19 many companies will realise that they need less space in future, and online will have an even bigger effect on retail sales. Chemicals looks like a value trap with troubled Sasol and Omnia.
Since February, before the full implications of the coronavirus outbreak were known, the proportion of managers who are bullish on equities on a 12month view has increased from 27% to 50%, but the bond bulls are now 29% of the sample, down from 33%. A net 36% of the sample are bears on cash and 21% on commodity prices.
The sample might be a tad overoptimistic, as it expects earnings per share to decline by a modest 14%.
THINGS COULD BE EVEN WORSE. THE HERD EXPECTS A 28% FALL IN THE ALL SHARE INDEX FROM ITS PEAK
BANKS ARE FACING A TRAUMATIC YEAR BUT ONE THING IS SURE, THE GOVERNMENT CANNOT AFFORD TO LET THEM FAIL